This article will explain the sell straddle, also known as the naked straddle option strategy. It is a neutral options strategy in the options market. In this strategy, traders sell a call option and a put option contract together, having the same strike price and expiry date. We shall study this strategy in detail, so stay with us till the end.
When can we apply this strategy? When you expect a very low or minimum price change in the underlying asset or, in other words, when the volatility is low, you can implement this strategy. When there is no major upcoming event in the market, the market is running slow and steady. That is the best time to implement the sell straddle strategy.
How to enter the sell straddle strategy?
As we said, it involves selling two option contracts, one call, and the other put. Thus, to enter the strategy, traders need to:
Sell call option contract
Sell put option contract
Breakeven points of the strategy:
As it is a multi-legged strategy, hence it has two breakeven points. The upper breakeven point is achieved when the underlying asset's price is equal to the strike call option price and the net premium paid. The lower breakeven point is achieved when the underlying asset's price is equal to the net difference between the strike price of the put contract and its premium paid.
Understand in simple terms:
Lower breakeven point = Put option strike price - Premium paid initially
Upper breakeven point = call option strike price - Premium paid initially
Max profit of the strategy:
In this strategy, the max profit is limited to the premium received by the trader initially. That can be achieved if the price of the underlying asset does not move or is equal to the strike price of any of the options contract ( call or put).
The benefit of using sell straddle or naked straddle strategy:
This strategy helps you to gain profit from the time decay factor.
It enables you to earn profit from the low volatile market scenario.
Let us now see how to exit from the strategy
In order to exit from the strategy, you can do the following:
Kindly wait for both options to expire and keep the premium in the form of profit.
Buy the call and put options contract again.
Eg. Nifty is currently trading @ 5600. Sell Straddle can be created by Selling Call and Put Option for Strike 5500 having premium of 65 and 35 respectively. Net inflow of premium is 100.
NIFTY (Lot size 50)
The Payoff Schedule and Chart for the above is below.
Net payoff (Rs.)
In the above chart, the breakeven happens the moment Nifty crosses 5500 or 5700 and reward is limited to a maximum of 5000 (calculated as Lot size * Premium received). Here it is important to note that the premium is calculated as the sum of premium received for the Call and Put option. The risk in such a strategy is unlimited.